When you purchase an annuity, you may convert your investment into a guaranteed stream of income spread out over a number of years, or throughout your entire lifetime. This is known as annuitization, and it’s basically what distinguishes an annuity from any other financial product such as an IRA, or individual retirement plans. Annuities can either be immediate (where you need to start receiving income right away), or deferred (where you need to build your contract value with time, then convert it to future income).
Immediate vs Deferred annuities
Deferred annuities do have an accumulation period (duration of time between depositing the premiums and when income payouts start, usually a number of years). On the other hand, immediate annuities do not have an accumulation period and income payouts start at most one year after deposit of premiums.
Differences between Immediate and Variable Annuities
| Immediate Annuities | Deferred Annuities |
| Income payouts start immediately (within 1-12 months) after lump sum premium is paid | Income payouts start at a pre-defined future date (usually a number of years), thus allowing time for accumulation |
| Contract bought with single premium | Contract bought with single premium or multiple periodic premiums |
| Contract is usually irrevocable | Contract may be exchanged with a different annuity, or surrendered all the same |
| No accumulation on tax-deferred basis | Assets accumulate tax-deferred |
| No federal tax penalty for payments starting before the age of 59½ | 10% federal tax penalty for on gains withdrawn or if contract is annuitized before the age of 59½ |
What are immediate annuities
When buying an immediate annuity, you’ll deposit a single-premium payment then say when you want to start receiving payouts (maybe in the next 1 month). You also have to specify the period of time through which you’ll receive income, and the amount you’ll receive in payouts. You can elect to receive income throughout your lifetime, or through the joint life of you or your spouse.
The amount of money you receive in monthly benefits is determined based on:
- The contract value of your annuity product.
- The payout options that you elect.
- Other personal factors such as your age.
- Whether your annuity is fixed, fixed indexed, or variable.
The appeal of immediate annuities
Immediate annuities have various features that make them an attractive retirement income choice. These annuities may be ideal for individuals who are worried about outliving their assets, or who have fears about how to manage a diversified portfolio. For instance, someone who receives a huge sum of cash from a bonus, retirement, or business profitability might choose to purchase an immediate annuity as a way to guarantee a steady source of retirement income. Also, people who receive a lump-sum distribution from a 401(k) may opt to convert this into steady retirement income by buying an immediate annuity.
Fixed or variable immediate annuities
Immediate annuities can be either fixed or variable. Most folks tend to prefer fixed immediate annuities since these provide predictable payouts. On the other hand, people who prefer variable immediate annuities are attracted by the growth potential, but this also comes at an additional risk of losing your principal in run down markets.
Deferred Annuities
A deferred annuity offers an opportunity to build retirement savings over time (usually a number of years). Between the time when you sign your contract and when you start receiving income payouts, your principal is stored in either a variable investment portfolio, a fixed account, or both.
While an immediate annuity is only purchased with a lump sum deposit, a deferred annuity can be purchased with a lump sum deposit, a series of small payments, or a combination of both. Where available, this flexible premium arrangement gives annuity owners an opportunity to amass an even larger retirement resource over time.
Usually – with a deferred annuity – you still have access to your funds. You can withdrawal a percentage of your contract each year free of any withdrawal charges, or surrender the entire contract value (in which case you’ll be subjected to surrender fees). Keep in mind that a 10% federal tax penalty is applicable if you withdraw your annuity funds before you hit the age of 59½.
